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Hopes Fade for Deal on Chinese Audit Firm Inspections

As recently as July, the PCAOB’s leadership believed it was close to reaching a deal to give its inspectors access to Chinese audit firms’ documents.In recent weeks, the preliminary deal’s terms have been reviewed by officials from ministries U.S. regulators haven’t negotiated with, and that’s feeding doubts that a joint-inspection agreement, if it comes, won’t be reached before 2015.

The PCAOB’s effort to gain permission to inspect auditors on the Chinese mainland seems to have lost momentum, and now there’s little chance that the board’s leadership can realize its goal of cutting a deal before the end of the year.

Following discussions with Chinese officials during the U.S.-China Strategic and Economic Dialogue in Beijing in July, PCAOB Chairman James Doty was optimistic an agreement could soon be reached.The dialogue is a yearly, bilateral forum between U.S. and Chinese senior officials.

“We expect the two sides to be able to reach agreement on a set of protocols in the coming months,” Doty said in July after negotiating with representatives from China’s Securities Regulatory Commission (CSRC) and Ministry of Finance (MOF).(See Chinese Audit Firm Inspections May Start by Year-End in the July 16, 2014, edition ofAccounting & Compliance Alert.)

Now that nearly three months have elapsed, and Doty toldAccounting & Compliance Alerton October 2, 2014, that he’s no longer as confident a deal can be reached.

“In July and shortly after July, the staff of the PCAOB had really reached acceptable conclusions with the staff of the CSRC and the staff of the MOF,” Doty said. “On our side and their side, there was a meeting of the minds on it.It went from that stage to being referred to the Ministry of Foreign Affairs, and I think, as I understand, also the Ministry of Justice.So you have at least one, if not two, other independent executive ministries of the People’s Republic of China who are looking over the shoulder of and looking at what the CSRC and MOF had concluded with us as a possible protocol.So I have no way of knowing or estimating” a timeline of an agreement.

In the past few years, the U.S. audit regulator’s negotiations with the CSRC and the MOF had produced few results.One of the first signs of progress materialized in May 2013, when U.S. and Chinese officials signed a memorandum of understanding about enforcement activities.Since then, the CSRC has been providing audit documents after checking them for state secrets.China bars direct production of audit documents to foreign regulators, and the Chinese believe their sovereignty is compromised if foreign regulators are allowed to come and inspect firms on site in China.

With another layer of review thrown in, things are less clear about when an inspection deal will be sealed.The manner in which an inspection will be carried out wasn’t disclosed, but a possibility involves the CSRC sending audit papers to the PCAOB after they’ve been reviewed by other Chinese officials.

“Our relationships with the CSRC, with Chairman Xiao Gang, with the people of the MOF, all of these relationships are as they should be in relations with the People’s Republic.They are sound, constructive, helpful relationships,” Doty said. “But our colleagues there have their limitations.We are trying to move as fast as we can.”

Doty believes that the CSRC and the MOF would like the deal to be reviewed by the State Council, which is the chief administrative authority of China, because the council may expedite approval.

“It will be pro forma, they will of course act on it,” Doty said. “The extent to which the Ministry of Foreign Affairs, or the Ministry of Justice either can or wish to keep this from going to the State Council, that’s something we don’t know.”

The agreement could still happen, but Doty said he has no information on the timing.

“But we have to start planning on the contingency that it doesn’t happen, which involves long-range planning,” he said. “And our colleagues understand that.This is not a case in which the legal issues on both sides are not understood by the other.I continue to believe we will get there.”